Waiting for the reverse mortgage surge
What happened to the mainstreaming of reverse mortgages in retirement plans?
became retirement researchers advance the idea For years, arguing that despite the high cost, financial planners need to consider the benefits of reverse loans to unlock home equity in retirement.
But credit activity remains flat. Home-equity convertible mortgage (HECM) volume ended 2021 at 53,020 loans — up 18.7% from 2020, but still in the range where issuance has recovered since 2012, according to Reverse Market Insight . And the volume of loans is well below the peak year of 2008, when 115,000 loans were issued.
From a market penetration perspective, HECMs are hardly a blip. “If you look at current loans by the number of eligible households, the penetration rate is just over 2%,” notes John Lunde, President of Reverse Market Insight.
HECMs are administered and regulated by the US Department of Housing and Urban Development (HUD). The federal government has implemented several reforms over the past decade aimed at curbing abusive lending practices. Defaults on payments had become an issue in the industry — especially when newspapers started running stories about seniors losing their homes. Although the loans have no payments, borrowers must keep their homeowner’s insurance and property taxes up to date and maintain the property.
The amendments reduced the total amounts of credit available, increased fees, and most importantly, introduced a required financial assessment to ensure borrowers were able to meet their obligations and conditions under the HECM.
Almost all reverse mortgages are generated under the HECM program. Fixed and variable rate HECM loans are available, but fixed rate loans are uncommon and require the borrower to draw all of the eligible credit upfront as a lump sum payment. More commonly, an HECM is structured as a line of credit that can be used for any purpose.
Because the distributions are loans, they’re not included in adjusted gross income reported on tax returns — meaning they don’t trigger large Medicare premiums or taxation on Social Security benefits. Federal insurance is provided by the Federal Housing Administration (FHA), which is part of the HUD. This backstop provides crucial collateral to both the borrower and the lender.
The lender has the assurance that the loans will be repaid even if the amount owed exceeds the proceeds from the sale of the home. The borrower gains the assurance of receiving the promised funds, that the heirs will never owe the HECM more than the value of the home at the time of repayment, and the protection offered by tight government regulation of a very complicated financial product.
Reverse mortgages are only available to homeowners aged 62 and over. As the name suggests, they are the opposite of a traditional “forward” mortgage, in which the borrower makes periodic payments to the bank to pay off debt and increase equity. A reverse mortgage pays off the home’s equity in cash with no payments due to the lender until you move, sell the property, or die.
Repayment of an HECM loan balance can be deferred until the last borrower or non-borrowing spouse dies, moves house, or sells the home. When the final repayment is due, ownership of the home remains with family members or heirs; They can choose to keep the home by paying off the loan or refinance it with a traditional mortgage. If they sell the house, they keep the profit over the loan repayment amount. If the loan balance exceeds the home’s value, the heirs can simply hand over the keys to the lender and walk away.
Retirement researchers have advocated the use of HECMs for some time. Recently, Wade Pfau, professor of retirement income at the American College of Financial Services, explored the benefits in his encyclopedic new book, Retirement Planning Guide: Navigating the key decisions for retirement success. In an interview, he argued that it is crucial for advisors to understand how revenue from a HECM can be integrated into a plan.
“If you can either slow down your withdrawal rate from your investments a bit or avoid payouts after a market downturn, it has such a tremendous positive impact on portfolio value later on,” he said. “That really is the secret of the reverse mortgage. You cannot look at the reverse mortgage in isolation, you must consider its impact on the overall plan and particularly on the investment portfolio.”
And Pfau does see interest, especially among registered investment advisors. “I think there’s at least a greater willingness to consider when they might play a role in a plan. So you will see more RIAs using them.”
Steve Resch, vice president of fixed income strategies at Finance of America Reverse, says it’s frustrating to see FHA product volume remaining in low gear. “In a fiduciary environment you look at all sorts of things that might be appropriate for a client. So how do you look at someone’s situation and think, “Well, homeownership could be really good for them” without even mentioning it to them?
However, he sees a growing interest from RIAs in using HECMs for a variety of retirement planning purposes. One challenge many clients face when they retire is the need to move some wealth from tax-deferred accounts to Roths to manage tax liability — and that can be expensive from a tax perspective. “We see some advisors using lines of credit to fund these tax liabilities,” he says.
Resch also sees growing interest from advisors in proprietary reverse mortgages, which have higher credit limits. These are not part of the HECM program and are not federally insured, but they are also non-recourse. It’s a much smaller chunk of the overall market, but it’s growing faster, he says.
“The loan-to-value ratios aren’t quite as generous as they are with FHA products because they’re insured and the lenders bear all the risk. But they are still non-recourse loans, and borrowers or their families are not liable for loan balances that exceed the value of the property,” he adds.
Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also writes for Morningstar and AARP magazine.